With netbooks' surprise success, Intel Corp.'s Atom processor has become an unexpected money-maker during a down period, bringing in a cool $719 million since its debut about a year ago.

But look beyond the immediate gain and Intel's cheaper CPU could be cannibalizing hundreds of millions — or even 1 billion — dollars from sales of its more profitable Core 2 mobile processors.

While Intel and a leading analyst deny Atom is a loser, others have said it is clearly cannibalizing sales, and one analyst now says Atom is hurting Intel on the supply-side as well.

Intel didn't report any Atom revenue in Q2 2008. But in the subsequent three quarters ending in March this year, it has reported $200 million, $300 million and $219 million in revenue, respectively.

Atom sales, however small in the context of Intel's overall revenue ($7.1 billion in the most recent quarter), would appear to be one of Intel's few bright spots. Sales were down 26% year-over-year, due to slowing demand for PCs.

Netbooks — net loser?

Gartner Inc., has presented convincing evidence that Atom netbooks are cannibalizing potential sales of regular notebook PCs. For instance, PC revenues during the key Christmas quarter fell as much as 20% year-over-year, despite a 1.1% increase in the number of PCs sold, Gartner said.

Now, Robert Castellano, an analyst with The Information Network is saying that Atom is hurting Intel on the supply side, because Intel is forced to manufacture the low-cost CPUs at the same state-of-the-art 45nm wafer plants it uses to create its Penryn family of Core 2 processors.

Intel sells Atom chips for about $29, versus the several hundred dollar average selling price of Penryn mobile CPUs, which include dual and quad-core chips, Castellano estimates.

Each typical 300-millimeter wafer can yield 2,436 Atom CPUs, versus 660 of the larger, more powerful Penryn chips, Castellano told Computerworld. Despite the four times greater yield in Atom chips, that doesn't make up for the greater profit Intel reaps from each Penryn sale, he said.

Using available data from Intel and third-party market researchers, Castellano has calculated that Atom has pulled more than 1 billion dollars from Intel's bottom line, resulting in the 55% year-over-year drop in the company's Q1 net income.

“[Intel's margins] would've been higher if they didn't make Atom processors [in-house],” he said. “I think Intel is not telling people the truth, which is that they can't make a $29 chip at a profit.”

Castellano said that Atom is the real reason for Intel's alliance with TSMC Co.

When the tie-up was announced in March, Intel emphasized that TSMC would help it boost Atom in the still-tiny Mobile Internet Device market as well as penetrate the smartphone market dominated by ARM Holdings PLC.

Intel's real goal, he argues, is to offload production of Atom CPUs for netbooks to TSMC, a Taiwanese chip foundry, to reclaim space in its own production lines for its profitable Penryn chips.

An Intel spokesman did say that the chipmaker hasn't publicly stated which kinds of Atom CPUs TSMC will be manufacturing. But that's because, at least in part, “we're still working on the exact details with them,” he said.

Intel: Atom is cream on top

The Intel spokesman declined to comment on Castellano's calculations. But he said Atom was boosting the company's profit.

“Atom sales in netbooks have given us extra growth and revenue we would not have otherwise seen,” the spokesman said in an e-mail. “We're seeing very little arbitrage from our Core-brand of processors as many people buy netbooks as companions to their laptops or as a third or forth home PC purchase.”

The spokesman continued, “We are comfortable with the margins we make on Atom and more than pleased with the early returns we're seeing from the family.”

Jack Gold, an independent mobile and semiconductor analyst, said Castellano's analysis relies on several flawed assumptions.

Atom production could only cannibalize Penryn chips if Intel's factories were running at full speed today. That's extremely unlikely, given the weak PC market and Intel's decision earlier this year to close down 4 factories and lay off 6,000 workers, he said.

“If Atoms were really displacing Core 2s, you'd see a shortage of Core 2 processors. But no PC vendor is crying about that,” Gold said.

Gold said that he believes Castellano underestimates the difference in yields between Atom and Penryn chips. The latter crams so many transistors in a tight space that the failure rate during the Penryn manufacturing process is higher than Castellano thinks, meaning the potential profits are lower, Gold said.

Also, TSMC's expertise is in creating specialized chipsets based on the Atom for very small devices like smartphones, not inexpensively manufacturing “plain vanilla” Atom netbook CPUs in high volumes, said Gold. But he did say Intel might use TSMC as a second source for Atom netbook CPUs if demand for Penryn/Core 2 chips pick up again.

But that scenario is also unlikely because Intel is starting to de-emphasize 45-nm Core 2 processors for its 32-nm Westmere chips that it will introduce in Q4. These chips will run faster and use less electricity than Penryn ones, and be priced accordingly.

“I understand the argument, but he's pulling at straws,” Gold said.

Analyst: All about the margins

Castellano said in reply that while Intel's older factories producing 65nm, 90nm and 110nm chips may have been underused — hence, the recent factory closures — its 45-nm factories are still “running pretty much flat-out,” he said. Intel would not comment on the assertion.

Castellano disagrees that the Penryns are much harder to manufacture than Atom CPUs. He points out that Atom chips, while having fewer transistors, are also roughly four times smaller.

Given that the cost of manufacturing is roughly equal — “same factories, same materials, same tools, same engineers” — the profit potential tilts heavily in the favor of Penryns.

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